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slm SuppFinInfo1Qtr07W33652A_2156_N_993
1. SLM CORPORATION
SUPPLEMENTAL FINANCIAL INFORMATION
FIRST QUARTER 2007
(Dollars in millions, except per share amounts, unless otherwise stated)
The following supplemental information should be read in connection with SLM Corporation’s (the
“Company’s”) press release of first quarter 2007 earnings, dated April 24, 2007.
This Supplemental Financial Information release contains forward-looking statements and information
that are based on management’s current expectations as of the date of this document. When used in this report,
the words “anticipate,” “believe,” “estimate,” “intend” and “expect” and similar expressions are intended to
identify forward-looking statements. These forward-looking statements are subject to risks, uncertainties,
assumptions and other factors that may cause the actual results to be materially different from those reflected
in such forward-looking statements. These factors include, among others, changes in the terms of student loans
and the educational credit marketplace arising from the implementation of applicable laws and regulations and
from changes in these laws and regulations, which may reduce the volume, average term and yields on student
loans under the Federal Family Education Loan Program (“FFELP”) or result in loans being originated or
refinanced under non-FFELP programs or may affect the terms upon which banks and others agree to sell
FFELP loans to SLM Corporation, more commonly known as Sallie Mae, and its subsidiaries (collectively,
“the Company”). In addition, a larger than expected increase in third party consolidations of our FFELP loans
could materially adversely affect our results of operations. The Company could also be affected by changes in
the demand for educational financing or in financing preferences of lenders, educational institutions, students
and their families; incorrect estimates or assumptions by management in connection with the preparation of
our consolidated financial statements; changes in the composition of our Managed FFELP and Private
Education Loan portfolios; a significant decrease in our common stock price, which may result in counter-
parties terminating equity forward positions with us, which, in turn, could have a materially dilutive effect on
our common stock; changes in the general interest rate environment and in the securitization markets for
education loans, which may increase the costs or limit the availability of financings necessary to initiate,
purchase or carry education loans; losses from loan defaults; changes in prepayment rates and credit spreads;
and changes in the demand for debt management services and new laws or changes in existing laws that
govern debt management services.
Definitions for capitalized terms in this document can be found in the Company’s 2006 Form 10-K filed
with the Securities and Exchange Commission (“SEC”) on March 1, 2007.
Certain reclassifications have been made to the balances as of and for the quarters ended December 31,
2006 and March 31, 2006, to be consistent with classifications adopted for the quarter ended March 31, 2007.
3. Earnings Release Summary
The following table summarizes GAAP income statement items disclosed separately in the Company’s
press releases of earnings or the Company’s quarterly earnings conference calls for the quarters ended
March 31, 2007, December 31, 2006, and March 31, 2006.
Quarters ended
March 31, December 31, March 31,
(in thousands) 2007 2006 2006
Reported net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $116,153 $ 18,105 $151,601
Preferred stock dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9,093) (9,258) (8,301)
Reported net income attributable to common stock . . . . . . . . . . . . . . . . 107,060 8,847 143,300
(Income) expense items disclosed separately (tax effected):
Update of Borrower Benefits estimates . . . . . . . . . . . . . . . . . . . . . . . — — (6,610)
Net income attributable to common stock excluding the impact of
items disclosed separately . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107,060 8,847 136,690
Adjusted for debt expense of Co-Cos, net of tax(1) . . . . . . . . . . . . . . . . — — —
Net income attributable to common stock, adjusted . . . . . . . . . . . . . . . $107,060 $ 8,847 $136,690
Average common and common equivalent shares outstanding(1)(2) . . . . . 418,449 418,357 422,974
(1)
For the three months ended March 31, 2007, December 31, 2006, and March 31, 2006, there is no impact from Co-Cos on diluted
earnings per common share because the effect of the assumed conversion is antidilutive.
(2)
The difference in common stock equivalent shares outstanding between GAAP and “Core Earnings” is caused by the effect of unreal-
ized gains and losses on equity forward contracts on the GAAP calculation. These unrealized gains and losses are excluded from
“Core Earnings.”
The following table summarizes “Core Earnings” income statement items disclosed separately in the
Company’s press releases of earnings or the Company’s quarterly earnings conference calls for the quarters
ended March 31, 2007, December 31, 2006, and March 31, 2006. See “BUSINESS SEGMENTS” for a
discussion of “Core Earnings” and a reconciliation of “Core Earnings” net income to GAAP net income.
Quarters ended
March 31, December 31, March 31,
(in thousands) 2007 2006 2006
“Core Earnings” net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $251,208 $325,747 $286,881
Preferred stock dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9,093) (9,258) (8,301)
“Core Earnings” net income attributable to common stock . . . . . . . . . . 242,115 316,489 278,580
(Income) expense items disclosed separately (tax effected):
Update of Borrower Benefits estimates . . . . . . . . . . . . . . . . . . . . . . . — — (9,339)
“Core Earnings” net income attributable to common stock excluding
the impact of items disclosed separately . . . . . . . . . . . . . . . . . . . . . . 242,115 316,489 269,241
Adjusted for debt expense of Co-Cos, net of tax . . . . . . . . . . . . . . . . . 17,510 18,035 14,817
“Core Earnings” net income attributable to common stock, adjusted . . . $259,625 $334,524 $284,058
Average common and common equivalent shares outstanding(1) . . . . . . 458,739 452,758 453,286
(1)
As noted above, for the three months ended March 31, 2007, December 31, 2006, and March 31, 2006, there is no impact from Co-
Cos on GAAP diluted earnings per common share because the effect of assumed conversion is antidilutive. The difference in common
stock equivalent shares outstanding between GAAP and “Core Earnings” is also caused by the effect of unrealized gains and losses
on equity forward contracts on the GAAP calculation. These unrealized gains and losses are excluded from “Core Earnings.”
3
4. DISCUSSION OF RESULTS OF OPERATIONS
Consolidated Earnings Summary
Three Months Ended March 31, 2007 Compared to Three Months Ended December 31, 2006
For the three months ended March 31, 2007, net income was $116 million ($.26 diluted earnings per
share), an increase of $98 million from the $18 million in net income ($.02 diluted earnings per share) for the
three months ended December 30, 2006. On a pre-tax basis, first-quarter 2007 net income of $427 million was
a $297 million increase over the $130 million in pre-tax income earned in the fourth quarter of 2006. The
larger percentage increase in quarter-over-quarter, after-tax net income versus pre-tax net income is driven by
the permanent impact of excluding non-taxable gains and losses on equity forward contracts in the Company’s
stock from taxable income. Under the Financial Accounting Standards Board’s (“FASB’s”) Statement of
Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity,” we are required to mark the equity forward contracts to market
each quarter and recognize the change in their value in income. Conversely, these gains and losses are not
recognized on a tax basis. In the first quarter of 2007, a reduction in the Company’s stock price resulted in an
unrealized loss on our outstanding equity forward contracts of $412 million, a $234 million increase over the
unrealized loss of $178 million in the fourth quarter of 2006. Excluding these losses from taxable income
decreased the effective tax rate from 86 percent in the fourth quarter of 2006 to 73 percent in the first quarter
of 2007.
When comparing the pre-tax results of the first quarter of 2007 to the fourth quarter of 2006, there were
several factors contributing to the $297 million increase, the two largest of which were an increase in
securitization gains of $367 million offset by an increase in the net losses on derivative and hedging activities
of $112 million. In the first quarter of 2007, we recognized a pre-tax securitization gain of $367 million from
one Private Education Loan securitization, compared to no such gains in the fourth quarter, as we had no off-
balance sheet securitizations during that period. The increase in net losses on derivative and hedging activities
primarily relates to the unrealized mark-to-market gains and losses on our derivatives that do not receive hedge
accounting treatment. In the first quarter, the $112 million increase in losses on derivative and hedging
activities is primarily due to the $234 million increase in the unrealized losses on our equity forward contracts
discussed above. This was partially offset by a $60 million unrealized gain on our basis swaps in the first
quarter of 2007 versus an $88 million unrealized loss in the fourth quarter of 2006, for a net quarter-over-quar-
ter change in net income of $148 million.
Net interest income after provisions for loan losses decreased by $16 million versus the fourth quarter.
The decrease is due to the quarter-over-quarter increase in the provision for Private Education Loan losses of
$58 million, which offset the $42 million increase in net interest income. The increase in the provision reflects
a further seasoning of the portfolio and an increase in delinquencies and charge-offs related to lower
collections caused by operational challenges related to a call center move in the third quarter of 2006. The
increase in net interest income is due to a 6 basis point increase in the net interest margin and to an $8.6 billion
increase in the average balance of on-balance sheet interest earning assets. The increase in the net interest
margin can be attributed to a more favorable mix of interest earning assets.
In the first quarter of 2007, our Managed student loan portfolio grew by $7.9 billion or 6 percent over the
fourth quarter and totaled $150.0 billion at March 31, 2007. During the first quarter we acquired $12.5 billion
in student loans, including $2.4 billion in Private Education Loans. In the fourth quarter of 2006, we acquired
$9.6 billion in student loans; $2.0 billion were Private Education Loans. In the first quarter of 2007, we
originated $8.0 billion of student loans through our Preferred Channel compared to $4.8 billion originated in
the fourth quarter of 2006. Within our first quarter Preferred Channel Originations, $4.8 billion or 60 percent
were originated under Sallie Mae owned brands, compared to 66 percent in the prior quarter. The quarter-over-
quarter increase in acquisitions and Preferred Channel Originations was due to the seasonality of student
lending.
4
5. Three Months Ended March 31, 2007 Compared to Three Months Ended March 31, 2006
For the three months ended March 31, 2007, net income of $116 million ($.26 diluted earnings per share)
was a decrease of 24 percent from net income of $152 million ($.34 diluted earnings per share) for the three
months ended March 31, 2006. First quarter 2007 pre-tax income of $427 million was a 47 percent increase
from $290 million earned in the first quarter of 2006. The decrease in current quarter over year-ago quarter,
after-tax net income versus the increase in pre-tax net income is driven by fluctuations in the unrealized gains
and losses on equity forward contracts as described above. Excluding the unrealized loss on equity forward
contracts of $412 million in the first quarter of 2007 and $122 million in the first quarter of 2006, taxable
income increased the effective tax rate from 47 percent in the first quarter of 2006 to 73 percent in the first
quarter of 2007.
The increase in the pre-tax results of the first quarter of 2007 versus the year-ago quarter was primarily
due to an increase in securitization gains of $337 million, partially offset by an increase in the net losses on
derivative and hedging activities of $270 million. In the first quarter of 2007, we recognized a pre-tax
securitization gain of $367 million from one Private Education Loan securitization compared to pre-tax
securitization gains of $30 million in the first quarter of 2006, as the result of two FFELP Stafford
securitizations and one FFELP Consolidation Loan securitization. The year-over-year increase in net losses on
derivative and hedging activities is primarily due to the $290 million increase in the unrealized loss on equity
forward contracts as discussed above and to a decrease of $139 million in the unrealized gains on our Floor
Income Contracts. The negative impact on pre-tax income from these items is partially offset by positive
impact from basis swaps which swung from an unrealized loss of $82 million in the first quarter of 2006 to an
unrealized gain of $60 million in the first quarter of 2007.
Net interest income after provisions for loan losses decreased by $63 million versus the first quarter of
2006. The decrease is due to the year-over-year increase in the provision for Private Education Loan losses of
$90 million, which offset the year-over-year $27 million increase net interest income. The increase in the
provision reflects a further seasoning of the portfolio and an increase in delinquencies and charge-offs related
to lower collections caused by operational challenges encountered from a call center move. The increase in net
interest income is due to a $19.8 billion increase in the average balance of on-balance sheet interest earning
assets, which was partially offset by a 22 basis point decrease in the net interest margin. The decrease in the
net interest margin can primarily be attributed to the decrease in the student loan spread.
In the first quarter of 2007, servicing and securitization income was $252 million, a $153 million increase
over the year-ago quarter. This increase can primarily be attributed to $41 million less impairments to our
Retained Interests. The prior year impairments were primarily caused by the effect of higher than expected
FFELP Consolidation Loan activity on our off-balance sheet FFELP Stafford securitizations. The remaining
increase in securitization revenue is due to the increase of higher yielding Private Education Loan Residual
Interests, and the adoption of SFAS No. 155 “Accounting for Certain Hybrid Financial Instruments” in the
first quarter of 2007. SFAS No. 155 results in the Company recognizing the unrealized fair value adjustment
to our Residual Interests in earnings. For securitizations closed prior to December 31, 2006, this adjustment
was recorded in other comprehensive income.
The $26 million, or 7 percent, year-over-year increase in net interest income is primarily due to a
$19.8 billion increase in average interest earning assets, offset by a 22 basis point decrease in the net interest
margin. The year-over-year decrease in the net interest margin is due to higher average interest rates which
reduced Floor Income by $10 million, the continued shift in the mix of FFELP student loans from Stafford to
Consolidation Loans and to the increase in the average balance of cash and investments.
In the first quarter of 2007, fee and other income and collections revenue totaled $289 million, an
increase of 17 percent over the year-ago quarter. This increase was primarily driven by revenue from
Upromise, acquired in August 2006 and to higher guarantor servicing fees.
Our Managed student loan portfolio grew by $23.1 billion (or 18 percent), from $126.9 billion at
March 31, 2006 to $150.0 billion at March 31, 2007. In the first quarter of 2007, we acquired $12.5 billion of
student loans, a 46 percent increase over the $8.6 billion acquired in the year-ago period. The first quarter
5
6. 2007 acquisitions included $2.4 billion in Private Education Loans, a 24 percent increase over the $2.0 billion
acquired in the year-ago period. In the quarter ended March 31, 2007, we originated $8.0 billion of student
loans through our Preferred Channel, an increase of 5 percent over the $7.6 billion originated in the year-ago
quarter.
NET INTEREST INCOME
Average Balance Sheets
The following table reflects the rates earned on interest earning assets and paid on interest bearing
liabilities for the quarters ended March 31, 2007, December 31, 2006, and March 31, 2006.
Quarters ended
March 31, December 31, March 31,
2007 2006 2006
Balance Rate Balance Rate Balance Rate
Average Assets
FFELP Stafford and Other Student Loans . . . . . $ 26,885 6.80% $ 23,287 6.96% $19,522 6.20%
FFELP Consolidation Loans . . . . . . . . . . . . . . 63,260 6.51 58,946 6.51 54,312 6.13
Private Education Loans . . . . . . . . . . . . . . . . . 11,354 12.09 9,289 12.45 9,016 10.86
Other loans . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,365 8.31 1,225 8.62 1,172 8.14
Cash and investments. . . . . . . . . . . . . . . . . . . . 7,958 5.81 9,433 6.02 7,042 5.52
Total interest earning assets . . . . . . . . . . . . . . . 110,822 7.12% 102,180 7.13% 91,064 6.59%
Non-interest earning assets . . . . . . . . . . . . . . . . 9,095 8,870 7,963
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . $119,917 $111,050 $99,027
Average Liabilities and Stockholders’ Equity
Short-term borrowings . . . . . . . . . . . . . . . . . . . $ 3,220 5.89% $ 3,057 5.96% $ 4,174 4.78%
Long-term borrowings . . . . . . . . . . . . . . . . . . . 107,950 5.58 99,349 5.66 87,327 4.85
Total interest bearing liabilities . . . . . . . . . . . . 111,170 5.59% 102,406 5.67% 91,501 4.84%
Non-interest bearing liabilities . . . . . . . . . . . . . 4,483 4,329 3,703
Stockholders’ equity . . . . . . . . . . . . . . . . . . . . 4,264 4,315 3,823
Total liabilities and stockholders’ equity . . . . . . $119,917 $111,050 $99,027
Net interest margin . . . . . . . . . . . . . . . . . . . . . 1.51% 1.45% 1.73%
The decrease and the increase in the net interest margin for the three months ended March 31, 2007
versus the year-ago quarter and the preceding quarter, respectively, was primarily due to fluctuations in the
student loan spread as discussed under “Student Loans — Student Loan Spread — Student Loan Spread
Analysis — On-Balance Sheet.” When compared to the fourth quarter of 2006, the net interest margin benefited
by the decrease in lower yielding cash and investments primarily being held as collateral for on-balance sheet
securitization trusts.
Student Loans
For both federally insured and Private Education Loans, we account for premiums paid, discounts
received and certain origination costs incurred on the origination and acquisition of student loans in
accordance with SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases.” The unamortized portion of the premiums and discounts
is included in the carrying value of the student loan on the consolidated balance sheet. We recognize income
on our student loan portfolio based on the expected yield of the student loan after giving effect to the
amortization of purchase premiums and the accretion of student loan discounts, as well as interest rate
6
7. reductions and rebates expected to be earned through Borrower Benefits programs. Discounts on Private
Education Loans are deferred and accreted to income over the lives of the student loans. In the table below,
this accretion of discounts is netted with the amortization of the premiums.
Student Loan Spread
An important performance measure closely monitored by management is the student loan spread. The
student loan spread is the difference between the income earned on the student loan assets and the interest
paid on the debt funding those assets. A number of factors can affect the overall student loan spread such as:
• the mix of student loans in the portfolio, with FFELP Consolidation Loans having the lowest spread
and Private Education Loans having the highest spread;
• the premiums paid, borrower fees charged and capitalized costs incurred to acquire student loans which
impact the spread through subsequent amortization;
• the type and level of Borrower Benefits programs for which the student loans are eligible;
• the level of Floor Income and, when considering the “Core Earnings” spread, the amount of Floor
Income-eligible loans that have been hedged through Floor Income Contracts; and
• funding and hedging costs.
Wholesale Consolidations Loan
During 2006, we implemented a new loan acquisition strategy under which we began purchasing FFELP
Consolidation Loans outside of our normal origination channels, primarily via the spot market. We refer to
this new loan acquisition strategy as our Wholesale Consolidation Channel. FFELP Consolidation Loans
acquired through this channel are considered incremental volume to our core acquisition channels, which are
focused on the retail marketplace with an emphasis on our internal brand strategy. Wholesale Consolidation
Loans generally command significantly higher premiums than our originated FFELP Consolidation Loans, and
as a result, Wholesale Consolidation Loans have lower spreads. Since Wholesale Consolidation Loans are
acquired outside of our core loan acquisition channels and have different yields and return expectations than
the rest of our FFELP Consolidation Loan portfolio, we have excluded the impact of the Wholesale
Consolidation Loan volume from the student loan spread analysis to provide more meaningful period-over-per-
iod comparisons on the performance of our student loan portfolio. We will therefore discuss the volume and
its effect on the spread of the Wholesale Consolidation Loan portfolio separately.
The student loan spread is highly susceptible to liquidity, funding and interest rate risk. These risks are
discussed separately in our 2006 Annual Report on Form 10-K at “LIQUIDITY AND CAPITAL
RESOURCES” and in the “RISK FACTORS” discussion.
7
8. Student Loan Spread Analysis — On-Balance Sheet
The following table analyzes the reported earnings from student loans on-balance sheet. For an analysis
of our student loan spread for the entire portfolio of Managed student loans on a similar basis to the on-
balance sheet analysis, see “LENDING BUSINESS SEGMENT — Student Loan Spread Analysis — ‘Core
Earnings’ Basis.”
Quarters ended
March 31, December 31, March 31,
2007 2006 2006
On-Balance Sheet
Student loan yield, before Floor Income ........................ 8.17% 8.15% 7.51%
Gross Floor Income . . . . . . . . . . . . . . . ........................ .02 .02 .07
Consolidation Loan Rebate Fees . . . . . . ........................ (.63) (.65) (.68)
Borrower Benefits . . . . . . . . . . . . . . . . ........................ (.13) (.12) (.11)
Premium and discount amortization. . . . ........................ (.15) (.14) (.12)
Student loan net yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.28 7.26 6.67
Student loan cost of funds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5.57) (5.65) (4.84)
Student loan spread(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.71% 1.61% 1.83%
Average Balances
On-balance sheet student loans(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $96,866 $89,143 $82,850
(1)
Excludes the impact of the Wholesale Consolidation Loan portfolio on the student loan spread and average balances for the quarters
ended March 31, 2007 and December 31, 2006.
Discussion of Student Loan Spread — Effects of Floor Income and Derivative Accounting
In low interest rate environments, one of the primary drivers of fluctuations in our on-balance sheet
student loan spread is the level of gross Floor Income (Floor Income earned before payments on Floor Income
Contracts) earned in the period. Short-term interest rates have increased to a level that significantly reduced
the level of gross Floor Income earned in the periods presented. We believe that we have economically hedged
most of the Floor Income through the sale of Floor Income Contracts, under which we receive an upfront fee
and agree to pay the counterparty the Floor Income earned on a notional amount of student loans. These
contracts do not qualify for hedge accounting treatment and as a result the payments on the Floor Income
Contracts are included on the income statement with “gains (losses) on derivative and hedging activities, net”
rather than in student loan interest income.
In addition to Floor Income Contracts, we also extensively use basis swaps to manage our basis risk
associated with interest rate sensitive assets and liabilities. These swaps generally do not qualify as accounting
hedges and are likewise required to be accounted for in the “gains (losses) on derivative and hedging activities,
net” line on the income statement. As a result, they are not considered in the calculation of the cost of funds
in the above table.
Discussion of Student Loan Spread — Other Quarter-over-Quarter Fluctuations
As discussed above, the on-balance sheet student loan spread above excludes the impact of our Wholesale
Consolidation Loan portfolio whose average balances were $4.6 billion and $2.4 billion for the first quarter of
2007 and the fourth quarter of 2006, respectively. Had the impact of the Wholesale Consolidation Loan
volume been included in the on-balance sheet student loan spread it would have reduced the spread by
approximately 7 basis points and 3 basis points for the first quarter of 2007 and the fourth quarter of 2006,
respectively. As of March 31, 2007, Wholesale Consolidation Loans totaled $6.7 billion, or 10 percent, of our
total on-balance sheet FFELP Consolidation Loan portfolio.
8
9. For the quarter ended December 31, 2006, the on-balance sheet student loan spread benefited by 2 basis
points to account for the cumulative effect of an update in our prepayment estimate, which impacted student
loan premium and discount amortization.
In the first quarter of 2006, we changed our policy related to Borrower Benefit qualification requirements
and updated our assumptions to reflect this policy. These changes resulted in a reduction of our liability for
Borrower Benefits of $10 million or 5 basis points.
SECURITIZATION PROGRAM
Securitization Activity
The following table summarizes our securitization activity for the quarters ended March 31, 2007,
December 31, 2006, and March 31, 2006.
Quarters ended
March 31, 2007 December 31, 2006 March 31, 2006
No. of Amount Pre-Tax Gain No. of Amount Pre-Tax Gain No. of Amount Pre-Tax Gain
(Dollars in millions) Transactions Securitized Gain % Transactions Securitized Gain % Transactions Securitized Gain %
Securitizations — sales:
FFELP Stafford/PLUS loans . . . . . . . . — $ — $ — —% — $ — $— —% 2 $5,004 $17 .3%
FFELP Consolidation Loans . . . . . . . . — — —— — — — — 1 3,002 13 .4
Private Education Loans. . . . . . . . . . . 1 2,000 367 18.4 — — — — — — — —
Total securitizations — sales . . . . . . . . 1 2,000 $367 18.4% — — $— —% 3 8,006 $30 .4%
Securitizations — financings:
FFELP Stafford/PLUS loans(1) . . . . . . . 2 7,004 — — — —
FFELP Consolidation Loans(1) . . . . . . . 1 4,002 2 6,504 — —
Total securitizations — financings . . . . . 3 11,006 2 6,504 — —
Total securitizations . . . . . . . . . . . . . 4 $13,006 2 $6,504 3 $8,006
(1)
In certain securitizations there are terms within the deal structure that result in such securitizations not qualifying for sale treatment
and accordingly, they are accounted for on-balance sheet as variable interest entities (“VIEs”). Terms that prevent sale treatment
include: (1) allowing us to hold certain rights that can affect the remarketing of certain bonds, (2) allowing the trust to enter into
interest rate cap agreements after the initial settlement of the securitization, which do not relate to the reissuance of third party bene-
ficial interests or (3) allowing us to hold an unconditional call option related to a certain percentage of the securitized assets.
Key economic assumptions used in estimating the fair value of Residual Interests at the date of securitization
resulting from the student loan securitization sale transactions completed during the quarters ended March 31,
2007, December 31, 2006, and March 31, 2006 were as follows:
Quarters ended
March 31, 2007 December 31, 2006 March 31, 2006
FFELP Private FFELP Private FFELP Private
FFELP Consolidation Education FFELP Consolidation Education FFELP Consolidation Education
Stafford(1) (1) (1) (1) (1)
Loans(1)
Loans Loans Stafford Loans Loans Stafford Loans
Prepayment speed (annual rate)(2) . . . . . . . . . . . . . — — — — — — * 6% —
Interim status . . . . . . . . . . . . . . . . . . . . . . . . — — 0% — — — — — —
Repayment status . . . . . . . . . . . . . . . . . . . . . . — — 4-7% — — — — — —
Life of loan — repayment status . . . . . . . . . . . . — — 6% — — — — — —
Weighted average life . . . . . . . . . . . . . . . . . . . . — — 9.4 — — — 3.7 8.3 —
Expected credit losses (% of principal securitized). . . — — 4.69% — — — .15% .27% —
Residual cash flows discounted at (weighted average) . . — — 12.5% — — — 12.4% 10.5% —
(1)
No securitizations qualified for sale treatment in the period.
(2)
Effective December 31, 2006, we implemented Constant Prepayment Rates (“CPR”) curves for Residual Interest valuations that are
based on the number of months since entering repayment that better reflect the CPR as the loan seasons. Under this methodology, a
different CPR is applied to each year of a loan’s seasoning. Previously, we applied a CPR that was based on a static life of loan
assumption, irrespective of seasoning, or, in the case of FFELP Stafford and PLUS loans, we used a vector approach in applying the
CPR. The repayment status CPR depends on the number of months since first entering repayment or as the loans seasons through the
portfolio. Life of loan CPR is related to repayment status only and does not include the impact of the loan while in interim status.
The CPR assumption used for all periods includes the impact of projected defaults.
* CPR of 20 percent in 2006, 15 percent for 2007 and 10 percent thereafter.
9
10. Retained Interest in Securitized Receivables
The following tables summarize the fair value of the Company’s Residual Interests, included in the
Company’s Retained Interest (and the assumptions used to value such Residual Interests), along with the
underlying off-balance sheet student loans that relate to those securitizations in transactions that were treated
as sales as of March 31, 2007, December 31, 2006, and March 31, 2006.
As of March 31, 2007
FFELP
FFELP Consolidation Private
Stafford and Loan Education
(1)
PLUS Trusts Loan Trusts Total
(2)
Fair value of Residual Interests . . . . . . . . . . . . . . . . . . $ 637 $ 671 $ 2,336 $ 3,644
Underlying securitized loan balance(3) . . . . . . . . . . . . . . 13,057 17,269 14,807 45,133
Weighted average life. . . . . . . . . . . . . . . . . . . . . . . . . . . 2.8 yrs. 7.2 yrs. 7.4 yrs.
Prepayment speed (annual rate)(4) . . . . . . . . . . . . . . . . . .
Interim status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0% — 0%
Repayment status . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0-43% 3-9% 4-7%
Life of loan — repayment status . . . . . . . . . . . . . . . . . 24% 6% 6%
Expected credit losses (% of student loan principal) . . . . .07% .06% 4.39%
Residual cash flows discount rate . . . . . . . . . . . . . . . . . . 12.4% 10.5% 12.5%
As of December 31, 2006
FFELP
FFELP Consolidation Private
Stafford and Loan Education
(1)
PLUS Trusts Loan Trusts Total
(2)
Fair value of Residual Interests . . . . . . . . . . . . . . . . . . $ 701 $ 676 $ 1,965 $ 3,342
Underlying securitized loan balance(3) . . . . . . . . . . . . . . 14,794 17,817 13,222 45,833
Weighted average life. . . . . . . . . . . . . . . . . . . . . . . . . . . 2.9 yrs. 7.3 yrs. 7.2 yrs.
Prepayment speed (annual rate)(4) . . . . . . . . . . . . . . . . . .
Interim status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0% — 0%
Repayment status . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0-43% 3-9% 4-7%
Life of loan — repayment status . . . . . . . . . . . . . . . . . 24% 6% 6%
Expected credit losses (% of student loan principal) . . . . .06% .07% 4.36%
Residual cash flows discount rate . . . . . . . . . . . . . . . . . . 12.6% 10.5% 12.6%
As of March 31, 2006
FFELP
FFELP Consolidation Private
Stafford and Loan Education
(1)
PLUS Trusts Loan Trusts Total
(2)
Fair value of Residual Interests . . . . . . . . . . . . . . . . . . $ 864 $ 499 $ 1,124 $ 2,487
Underlying securitized loan balance(3) . . . . . . . . . . . . . . 23,104 12,857 8,836 44,797
Weighted average life. . . . . . . . . . . . . . . . . . . . . . . . . . . 3.5 yrs. 7.9 yrs. 7.7 yrs.
Prepayment speed (annual rate)(4) . . . . . . . . . . . . . . . . . . 10%-20%(5) 6% 4%
Expected credit losses (% of student loan principal) . . . . .18% .22% 4.92%
Residual cash flows discount rate . . . . . . . . . . . . . . . . . . 12.7% 10.7% 12.8%
(1)
Includes $147 million, $151 million and $160 million related to the fair value of the Embedded Floor Income as of March 31, 2007,
December 31, 2006, and March 31, 2006, respectively. Changes in the fair value of the Embedded Floor Income are primarily due to
changes in the interest rates and the paydown of the underlying loans.
(2)
At March 31, 2007, December 31, 2006, and March 31, 2006, we had unrealized gains (pre-tax) in accumulated other comprehensive
income of $332 million, $389 million and $323 million, respectively, that related to the Retained Interests.
(3)
In addition to student loans in off-balance sheet trusts, we had $58.2 billion, $48.6 billion and $39.9 billion of securitized student
loans outstanding (face amount) as of March 31, 2007, December 31, 2006, and March 31, 2006, respectively, in on-balance sheet
FFELP Consolidation Loan securitization trusts.
(4)
Effective December 31, 2006, we implemented CPR curves for Residual Interest valuations that are based on seasoning (the number
of months since entering repayment). Under this methodology, a different CPR is applied to each year of a loan’s seasoning. Previ-
ously, we applied a CPR that was based on a static life of loan assumption, and, in the case of FFELP Stafford and PLUS loans, we
applied a vector approach, irrespective of seasoning. Repayment status CPR used is based on the number of months since first enter-
ing repayment (seasoning). Life of loan CPR is related to repayment status only and does not include the impact of the loan while in
interim status. The CPR assumption used for all periods includes the impact of projected defaults.
(5)
CPR of 20 percent in 2006, 15 percent in 2007 and 10 percent thereafter.
10
11. Servicing and Securitization Revenue
Servicing and securitization revenue, the ongoing revenue from securitized loan pools accounted for off-
balance sheet as qualifying special purpose entities (“QSPEs”), includes the interest earned on the Residual
Interest and the revenue we receive for servicing the loans in the securitization trusts. Interest income
recognized on the Residual Interest is based on our anticipated yield determined by estimating future cash
flows each quarter.
The following table summarizes the components of servicing and securitization revenue for the quarters
ended March 31, 2007, December 31, 2006, and March 31, 2006.
Quarters ended
March 31, December 31, March 31,
2007 2006 2006
Servicing revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 77 $ 82 $ 79
Securitization revenue, before net Embedded Floor Income and
impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 112 69
Servicing and securitization revenue, before net Embedded Floor
Income and impairment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183 194 148
Embedded Floor Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2 7
Less: Floor Income previously recognized in gain calculation . . . . . . . . (1) (1) (4)
Net Embedded Floor Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1 3
Servicing and securitization revenue, before impairment and unrealized
fair value adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184 195 151
Unrealized fair value adjustment(1) . . . . . . . . . . . . . . . . . . . . . . . . . . 79 — —
Retained Interest impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (11) (10) (52)
Total servicing and securitization revenue . . . . . . . . . . . . . . . . . . . . . . . $ 252 $ 185 $ 99
Average off-balance sheet student loans. . . . . . . . . . . . . . . . . . . . . . . . . $44,663 $47,252 $42,069
Average balance of Retained Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,442 $ 3,502 $ 2,501
Servicing and securitization revenue as a percentage of the average
balance of off-balance sheet student loans (annualized) . . . . . . . . . . . 2.29% 1.55% .95%
(1)
The Company adopted SFAS No. 155 on January 1, 2007. For the Private Education Loan securitization which settled in the first
quarter of 2007, the Company identified embedded derivatives which were required to be bifurcated from the Residual Interest.
SFAS No. 155 allows the Company to make an election to carry the entire Residual Interest at fair value through earnings rather than
bifurcate such embedded derivatives. The Company has elected this option to carry the Residual Interest recorded in the quarter ended
March 31, 2007 at fair value, with changes in fair value recorded through earnings (as opposed to other comprehensive income as
done for securitizations settling prior to January 1, 2007).
Servicing and securitization revenue is primarily driven by the average balance of off-balance sheet
student loans, the amount of and the difference in the timing of Embedded Floor Income recognition on off-
balance sheet student loans, Retained Interest impairments, and the fair value adjustment related to those
Residual Interests where the Company has elected to carry such Residual Interests at fair value through
earnings under SFAS No. 155 as discussed in the above table.
Servicing and securitization revenue can be negatively impacted by impairments of the value of our
Retained Interest, caused primarily by the effect of higher than expected FFELP Consolidation Loan activity
on FFELP Stafford/PLUS student loan securitizations and the effect of market interest rates on the Embedded
Floor Income included in the Retained Interest. The majority of the consolidations bring the loans back on-
balance sheet, so for those loans, we retain the value of the asset on-balance sheet versus in the trust. For the
quarters ended March 31, 2007, December 31, 2006, and March 31, 2006, we recorded impairments to the
Retained Interests of $11 million, $10 million and $52 million, respectively. The impairment charges were
primarily the result of FFELP loans prepaying faster than projected through loan consolidations ($11 million,
$10 million and $24 million for the quarters ended March 31, 2007, December 31, 2006 and March 31, 2006,
respectively). The impairment for the quarter ended March 31, 2006 also related to the Floor Income
11
12. component of the Company’s Retained Interest due to increases in interest rates during the period ($28 million).
The unrealized fair value adjustment recorded relates to the difference between recording the Residual Interest
at its allocated cost basis as part of the gain on sale calculation and the Residual Interest’s fair value.
BUSINESS SEGMENTS
The results of operations of the Company’s Lending and Debt Management Operations (“DMO”)
operating segments are presented below. These defined business segments operate in distinct business
environments and are considered reportable segments under SFAS No. 131, “Disclosures about Segments of an
Enterprise and Related Information,” based on quantitative thresholds applied to the Company’s financial
statements. In addition, we provide other complementary products and services, including guarantor and
student loan servicing, through smaller operating segments that do not meet such thresholds and are aggregated
in the Corporate and Other reportable segment for financial reporting purposes.
The management reporting process measures the performance of the Company’s operating segments based
on the management structure of the Company as well as the methodology used by management to evaluate
performance and allocate resources. In accordance with the Rules and Regulations of the SEC, we prepare
financial statements in accordance with GAAP. In addition to evaluating the Company’s GAAP-based financial
information, management, including the Company’s chief operating decision maker, evaluates the performance
of the Company’s operating segments based on their profitability on a basis that, as allowed under
SFAS No. 131, differs from GAAP. We refer to management’s basis of evaluating our segment results as “Core
Earnings” presentations for each business segment and we refer to these performance measures in our
presentations with credit rating agencies and lenders. Accordingly, information regarding the Company’s
reportable segments is provided herein based on “Core Earnings,” which are discussed in detail below.
Our “Core Earnings” are not defined terms within GAAP and may not be comparable to similarly titled
measures reported by other companies. “Core Earnings” net income reflects only current period adjustments to
GAAP net income as described below. Unlike financial accounting, there is no comprehensive, authoritative
guidance for management reporting and as a result, our management reporting is not necessarily comparable
with similar information for any other financial institution. The Company’s operating segments are defined by
the products and services they offer or the types of customers they serve, and they reflect the manner in which
financial information is currently evaluated by management. Intersegment revenues and expenses are netted
within the appropriate financial statement line items consistent with the income statement presentation
provided to management. Changes in management structure or allocation methodologies and procedures may
result in changes in reported segment financial information.
“Core Earnings” are the primary financial performance measures used by management to develop the
Company’s financial plans, track results, and establish corporate performance targets and incentive compensa-
tion. While “Core Earnings” are not a substitute for reported results under GAAP, the Company relies on
“Core Earnings” in operating its business because “Core Earnings” permit management to make meaningful
period-to-period comparisons of the operational and performance indicators that are most closely assessed by
management. Management believes this information provides additional insight into the financial performance
of the core business activities of our operating segments. Accordingly, the tables presented below reflect “Core
Earnings,” which is reviewed and utilized by management to manage the business for each of the Company’s
reportable segments. A further discussion regarding “Core Earnings” is included under “Limitations of ‘Core
Earnings’” and “Pre-tax Differences between ‘Core Earnings’ and GAAP.”
The Lending operating segment includes all discussion of income and related expenses associated with
the net interest margin, the student loan spread and its components, the provisions for loan losses, and other
fees earned on our Managed portfolio of student loans. The DMO operating segment reflects the fees earned
and expenses incurred in providing accounts receivable management and collection services. Our Corporate
12
13. and Other reportable segment includes our remaining fee businesses and other corporate expenses that do not
pertain directly to the primary segments identified above.
Quarter ended March 31, 2007
Corporate Total “Core Total
Adjustments(3)
Lending DMO and Other Earnings” GAAP
Interest income:
FFELP Stafford and Other Student Loans . . $ 695 $— $— $ 695 $(244) $ 451
FFELP Consolidation Loans . . . . . . . . . . . . 1,331 — — 1,331 (316) 1,015
Private Education Loans . . . . . . . . . . . . . . . 658 — — 658 (320) 338
Other loans . . . . . . . . . . . . . . . . . . . . . . . . . 28 — — 28 — 28
Cash and investments . . . . . . . . . . . . . . . . . 162 — 2 164 (50) 114
Total interest income . . . . . . . . . . ......... 2,874 — 2 2,876 (930) 1,946
Total interest expense . . . . . . . . . . ......... 2,220 7 5 2,232 (700) 1,532
Net interest income . . . . . . . . . . . ......... 654 (7) (3) 644 (230) 414
Less: provisions for losses . . . . . . ......... 198 — 1 199 (49) 150
Net interest income after provisions for
losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 456 (7) (4) 445 (181) 264
Fee income . . . . . . . . . . . . . . . . . . . . . . . . . . — 87 39 126 — 126
Collections revenue . . . . . . . . . . . . . . . . . . . . — 65 — 65 1 66
Other income . . . . . . . . . . . . . . . . . . . . . . . . . 44 — 52 96 231 327
Total other income . . . . . . . . . . . . . . . . . . . . . 44 152 91 287 232 519
Operating expenses(1) . . . . . . . . . . . . . . . . . . . 171 93 68 332 24 356
Income before income taxes and minority
interest in net earnings of subsidiaries . . . . . 329 52 19 400 27 427
Income tax expense(2) . . . . . . . . . . . . . . . . . . . 122 19 7 148 162 310
Minority interest in net earnings of
subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . — 1 — 1 — 1
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . $ 207 $ 32 $12 $ 251 $(135) $ 116
(1)
Operating expenses for the Lending, DMO, and Corporate and Other business segments include $9 million, $3 million, and $4 million,
respectively, of stock option compensation expense due to the implementation of SFAS No. 123(R) in the first quarter of 2006.
(2)
Income taxes are based on a percentage of net income before tax for the individual reportable segment.
(3)
“Core Earnings” adjustments to GAAP:
Quarter ended March 31, 2007
Net impact of Net impact of Net impact
securitization derivative Net impact of of acquired
accounting accounting Floor Income intangibles Total
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(216) $ 25 $(39) $— $(230)
Less: provisions for losses . . . . . . . . . . . . . . . . . . . . . . . . (49) — — — (49)
Net interest income after provisions for losses . . . . . . . . . . . (167) 25 (39) — (181)
Fee income . . . . . . . . . .............. . . . . . . . . . . . — — — — —
Collections revenue . . . .............. . . . . . . . . . . . 1 — — — 1
Other income . . . . . . . .............. . . . . . . . . . . . 588 (357) — — 231
Total other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 589 (357) — — 232
Operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — 24 24
Total pre-tax “Core Earnings” adjustments to GAAP . . . . . . . $ 422 $(332) $(39) $(24) 27
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162
Minority interest in net earnings of subsidiaries . . . . . . . . . . —
Total “Core Earnings” adjustments to GAAP . . . . . . . . . . . . $(135)
13
16. Reconciliation of “Core Earnings” Net Income to GAAP Net Income
Quarters ended
March 31, December 31, March 31,
2007 2006 2006
“Core Earnings” net income(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 251 $ 326 $ 287
“Core Earnings” adjustments:
Net impact of securitization accounting . . . . . . . . . . . . . . . . . . . . . . . 422 (68) (62)
Net impact of derivative accounting. . . . . . . . . . . . . . . . . . . . . . . . . . (332) (243) (39)
Net impact of Floor Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (39) (52) (52)
Net impact of acquired intangibles(2) . . . . . . . . . . . . . . . . . . . . . . . . . (24) (25) (14)
Total “Core Earnings” adjustments before income taxes . . . . . . . . . . . . . 27 (388) (167)
Net tax effect(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (162) 80 32
Total “Core Earnings” adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . (135) (308) (135)
GAAP net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 116 $ 18 $ 152
GAAP diluted earnings per common share . . . . . . . . . . . . . . . . . . . . $ .26 $ .02 $ .34
(1)
“Core Earnings” diluted earnings per common share . . . . . . . . . . . . . . . . . . . . . . . $ .57 $ .74 $ .65
(2)
Represents goodwill and intangible impairment and the amortization of acquired intangibles.
(3)
Such tax effect is based upon the Company’s “Core Earnings” effective tax rate for the year. The net tax effect results primarily from
the exclusion of the permanent income tax impact of the equity forward contracts.
Limitations of “Core Earnings”
While GAAP provides a uniform, comprehensive basis of accounting, for the reasons described above,
management believes that “Core Earnings” are an important additional tool for providing a more complete
understanding of the Company’s results of operations. Nevertheless, “Core Earnings” are subject to certain
general and specific limitations that investors should carefully consider. For example, as stated above, unlike
financial accounting, there is no comprehensive, authoritative guidance for management reporting. Our “Core
Earnings” are not defined terms within GAAP and may not be comparable to similarly titled measures
reported by other companies. Unlike GAAP, “Core Earnings” reflect only current period adjustments to GAAP.
Accordingly, the Company’s “Core Earnings” presentation does not represent a comprehensive basis of
accounting. Investors, therefore, may not compare our Company’s performance with that of other financial
services companies based upon “Core Earnings.” “Core Earnings” results are only meant to supplement GAAP
results by providing additional information regarding the operational and performance indicators that are most
closely used by management, the Company’s board of directors, rating agencies and lenders to assess
performance.
Other limitations arise from the specific adjustments that management makes to GAAP results to derive
“Core Earnings” results. For example, in reversing the unrealized gains and losses that result from
SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” on derivatives that do not
qualify for “hedge treatment,” as well as on derivatives that do qualify but are in part ineffective because they
are not perfect hedges, we focus on the long-term economic effectiveness of those instruments relative to the
underlying hedged item and isolate the effects of interest rate volatility, changing credit spreads and changes
in our stock price on the fair value of such instruments during the period. Under GAAP, the effects of these
factors on the fair value of the derivative instruments (but not on the underlying hedged item) tend to show
more volatility in the short term. While our presentation of our results on a “Core Earnings” basis provides
important information regarding the performance of our Managed portfolio, a limitation of this presentation is
that we are presenting the ongoing spread income on loans that have been sold to a trust managed by us.
While we believe that our “Core Earnings” presentation presents the economic substance of our Managed loan
portfolio, it understates earnings volatility from securitization gains. Our “Core Earnings” results exclude
certain Floor Income, which is real cash income, from our reported results and therefore may understate
16
17. earnings in certain periods. Management’s financial planning and valuation of operating results, however, does
not take into account Floor Income because of its inherent uncertainty, except when it is economically hedged
through Floor Income Contracts.
Pre-tax Differences between “Core Earnings” and GAAP
Our “Core Earnings” are the primary financial performance measures used by management to evaluate
performance and to allocate resources. Accordingly, financial information is reported to management on a
“Core Earnings” basis by reportable segment, as these are the measures used regularly by our chief operating
decision maker. Our “Core Earnings” are used in developing our financial plans and tracking results, and also
in establishing corporate performance targets and determining incentive compensation. Management believes
this information provides additional insight into the financial performance of the Company’s core business
activities. “Core Earnings” net income reflects only current period adjustments to GAAP net income, as
described in the more detailed discussion of the differences between “Core Earnings” and GAAP that follows,
which includes further detail on each specific adjustment required to reconcile our “Core Earnings” segment
presentation to our GAAP earnings.
1) Securitization: Under GAAP, certain securitization transactions in our Lending operating segment are
accounted for as sales of assets. Under “Core Earnings” for the Lending operating segment, we present all
securitization transactions on a “Core Earnings” basis as long-term non-recourse financings. The upfront
“gains” on sale from securitization transactions as well as ongoing “servicing and securitization revenue”
presented in accordance with GAAP are excluded from “Core Earnings” and are replaced by the interest
income, provisions for loan losses, and interest expense as they are earned or incurred on the securitization
loans. We also exclude transactions with our off-balance sheet trusts from “Core Earnings” as they are
considered intercompany transactions on a “Core Earnings” basis.
The following table summarizes the securitization adjustments in our Lending business segment for the
quarters ended March 31, 2007, December 31, 2006, and March 31, 2006.
Quarters ended
March 31, December 31, March 31,
2007 2006 2006
“Core Earnings” securitization adjustments:
Net interest income on securitized loans, after provisions for losses . . . . $(167) $(233) $(189)
Gains on student loan securitizations . . . . . . . . . . . . . . . . . . . . . . . . . . . 367 — 30
Servicing and securitization revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . 252 185 99
Intercompany transactions with off-balance sheet trusts . . . . . . . . . . . . . (30) (20) (2)
Total “Core Earnings” securitization adjustments . . . . . . . . . . . . . . . . . . $ 422 $ (68) $ (62)
2) Derivative Accounting: “Core Earnings” exclude periodic unrealized gains and losses arising
primarily in our Lending operating segment, and to a lesser degree in our Corporate and Other reportable
segment, that are caused primarily by the one-sided mark-to-market derivative valuations prescribed by
SFAS No. 133 on derivatives that do not qualify for “hedge treatment” under GAAP. Under “Core Earnings,”
we recognize the economic effect of these hedges, which generally results in any cash paid or received being
recognized ratably as an expense or revenue over the hedged item’s life. “Core Earnings” also exclude the
gain or loss on equity forward contracts that under SFAS No. 133, are required to be accounted for as
derivatives and are marked-to-market through earnings.
SFAS No. 133 requires that changes in the fair value of derivative instruments be recognized currently in
earnings unless specific hedge accounting criteria, as specified by SFAS No. 133, are met. We believe that our
derivatives are effective economic hedges, and as such, are a critical element of our interest rate risk
management strategy. However, some of our derivatives, primarily Floor Income Contracts, certain basis swaps
and equity forward contracts (discussed in detail below), do not qualify for “hedge treatment” as defined by
SFAS No. 133, and the stand-alone derivative must be marked-to-market in the income statement with no
consideration for the corresponding change in fair value of the hedged item. The gains and losses described in
17
18. “Gains (losses) on derivative and hedging activities, net” are primarily caused by interest rate volatility,
changing credit spreads and changes in our stock price during the period as well as the volume and term of
derivatives not receiving hedge treatment.
Our Floor Income Contracts are written options that must meet more stringent requirements than other
hedging relationships to achieve hedge effectiveness under SFAS No. 133. Specifically, our Floor Income
Contracts do not qualify for hedge accounting treatment because the paydown of principal of the student loans
underlying the Floor Income embedded in those student loans does not exactly match the change in the
notional amount of our written Floor Income Contracts. Under SFAS No. 133, the upfront payment is deemed
a liability and changes in fair value are recorded through income throughout the life of the contract. The
change in the value of Floor Income Contracts is primarily caused by changing interest rates that cause the
amount of Floor Income earned on the underlying student loans and paid to the counterparties to vary. This is
economically offset by the change in value of the student loan portfolio, including our Retained Interests,
earning Floor Income but that offsetting change in value is not recognized under SFAS No. 133. We believe
the Floor Income Contracts are economic hedges because they effectively fix the amount of Floor Income
earned over the contract period, thus eliminating the timing and uncertainty that changes in interest rates can
have on Floor Income for that period. Prior to SFAS No. 133, we accounted for Floor Income Contracts as
hedges and amortized the upfront cash compensation ratably over the lives of the contracts.
Basis swaps are used to convert floating rate debt from one floating interest rate index to another to better
match the interest rate characteristics of the assets financed by that debt. We primarily use basis swaps to
change the index of our floating rate debt to better match the cash flows of our student loan assets that are
primarily indexed to a commercial paper, Prime or Treasury bill index. SFAS No. 133 requires that when
using basis swaps, the change in the cash flows of the hedge effectively offset both the change in the cash
flows of the asset and the change in the cash flows of the liability. Our basis swaps hedge variable interest rate
risk, however they generally do not meet this effectiveness test because most of our FFELP student loans can
earn at either a variable or a fixed interest rate depending on market interest rates. We also have basis swaps
that do not meet the SFAS No. 133 effectiveness test that economically hedge off-balance sheet instruments.
As a result, under GAAP these swaps are recorded at fair value with changes in fair value reflected currently
in the income statement.
Generally, a decrease in current interest rates and the respective forward interest rate curves results in an
unrealized loss related to our written Floor Income Contracts which is offset by an increase in the value of the
economically hedged student loans. This increase is not recognized in income. We will experience unrealized
gains/losses related to our basis swaps if the two underlying indices (and related forward curve) do not move
in parallel.
Under SFAS No. 150, equity forward contracts that allow a net settlement option either in cash or the
Company’s stock are required to be accounted for as derivatives in accordance with SFAS No. 133. As a
result, we account for our equity forward contracts as derivatives in accordance with SFAS No. 133 and mark
them to market through earnings. These contracts do not qualify as effective SFAS No. 133 hedges, because a
requirement to achieve hedge accounting under SFAS No. 133 is the hedged item must impact net income and
transactions related to our own stock are accounted for in equity, not net income.
The table below quantifies the adjustments for derivative accounting under SFAS No. 133 on our net
income for the quarters ended March 31, 2007, December 31, 2006, and March 31, 2006, when compared
with the accounting principles employed in all years prior to the SFAS No. 133 implementation.
18
